Robert J. Samuelson: A new bull market  or a bubble?

By Robert J. Samuelson, Columnist

Thursday, March 14, 2013

Where’s the stock market going? Has a bull market started? Or are we on the cusp of a new bubble?

As I argued in my last column — which noted that stocks have reached new highs — the answers matter beyond individual investment portfolios. Stock prices influence consumer and business confidence and spending. A strong market will bolster the recovery; a weak market will hinder it.

Unfortunately, it’s hard to predict the market. Legions of analysts try; few succeed. In reporting my last column, I stumbled across two fascinating analyses — one optimistic, the other pessimistic. I didn’t find one right and the other wrong. Together, they’re a tutorial in how to think about the market.

The pessimistic report comes from Credit Suisse. It warns:

“To assume that savers can confidently expect large wealth increases from investing over the long term in the stock market — in essence that the investment conditions of the 1990s will return — is delusional.”

Here are the numbers. Since 1980, U.S. stocks have earned an average “real” return (that is, adjusted for inflation) of about 7 percent a year. But over the next two or three decades, the Credit Suisse analysts expect the “real” annual returns to average only 3.5 percent at most, though some years will be better or worse than others. The difference is huge. With average gains of 7 percent, stocks would double their value in a decade; at 3.5 percent, it would take twice as long.

Without saying so, Credit Suisse anticipates a world of mediocre investment opportunities. Profits improve but not spectacularly. For investors, bonds do not offer a better alternative. Although bond returns have been high since 1980, the Credit Suisse analysts don’t expect that to continue. Present rates on long-term U.S. Treasury bonds, after adjusting for expected inflation, are close to zero. Credit Suisse predicts they will stay at less than 1 percent, depressed by the Federal Reserve’s easy-money policies and a high investor demand for bonds of “safe haven” countries, led presumably by the United States.

If vindicated, this analysis has profound implications. Achieving any given level of income will require investors to save more and spend less. But investors often “seem to be in denial” about low returns, Credit Suisse asserts.

“Many asset managers still state that their long-run performance objective is to beat inflation by 6 percent, 7 percent or even 8 percent. Such aims are unrealistic in today’s low-return world,” the report argues. “Pension plans are also too optimistic, especially in the USA.” Translation: Many pension plans are more underfunded than realized. Contributions will have to increase. For private companies, this means a hit to either profits or workers’ wages. For state and local governments, it means higher taxes, smaller wage increases or cuts in public services.

But Credit Suisse could be wrong. Enter economic historian Richard Sylla of New York University, who has constructed a time series of “real” U.S. stock returns since 1791. His figures disabuse any notion that the market has grown more stable. Since 1871 — when the data improve — annual returns have averaged about 6.5 percent, but there are huge, often-double-digit swings up and down. “The cycles of overall returns haven’t changed much in two centuries,” Sylla said in an email. “The market is as risky and potentially profitable as it was a hundred and two hundred years ago.”

And that’s the case for optimism. As Sylla observes, periods of low returns tend to be followed by periods of higher returns and vice versa. So the good news is the bad news. The years after the bursting of the “tech bubble” — itself a period of exceptionally high returns — were dismal for stocks. According to Sylla’s data, the average return on stocks for the years 2000 to 2011 was slightly negative. The new highs achieved in the last month only barely surpass previous highs in 2000 and 2007.

For Sylla, the cycle is turning, though stock gains aren’t guaranteed in any year. “I do think this decade will turn out much better for investors than the last one did,” he wrote.

Who’s right? We’ll know in a decade or so.

Robert Samuelson is a columnist for The Washington Post who specializes in economic issues.